George Pitcher: Banks can do better than lending to a buy-to-letter

There can be no surer sign that the mortgage markets have peaked, and that there is no way but down for borrowers and lenders alike, than the news that British Airways has mortgaged some of its aircraft for &£600m.

As the markets for business and tourist travel deteriorate, there may come a time when BA is left facing the negative equity trap. I have a vision of BA chairman Lord Marshall being left with no alternative other than to go to his bank and push the keys to the hangar through the letterbox.

BA’s lenders will then find themselves in possession of a collection of Boeings for which there is no ready sales market in which to recoup their loan, so one is left wondering what they will do with a fleet of vacant aircraft. Rent them out to a housing association, I suppose.

In an economy that can only be described as schizophrenic – manufacturing in recession, while a consumer spending boom rages – I suppose that there is nothing particularly eccentric about a mortgage market where money is lent willy-nilly to customers about to see their assets crash in value.

I have heard stories about house-purchasers being offered loans that amount to eight times their annual earnings. We weren’t doing that even when Margaret Thatcher was in Downing Street and the property markets had kidded themselves that they were in an eternal boom.

The rationale behind the stretching of the chains that tie mortgage lending to average earnings is that we have an entrenched regime of low interest rates, unemployment remains relatively minimal and the popular view is that economic growth will return by the second half of this year.

Well, that’s all right then. Until you start to look at some of the lending institutions. Remember, these were the banks responsible for the investment of a cornucopia of cash in Third World economies that never developed and commercial property companies that went bust.

Late last week, Lloyds TSB’s shares fell more than 40p – or five per cent – not so much on the news that it is to lay off 3,000 staff this year, but rather on nervousness that the company saw fit to raise its provisions against bad debts this year by 46 per cent to &£792m.

These provisions include a &£100m charge against Argentine debts, as the bank assumed that half of its loans to a nation on the point of insurrection would never be repaid. Old habits clearly die hard for British banks – they have long had an uncanny knack for backing regimes that renege on their loan covenants.

If this is the quality of Lloyds TSB’s husbandry of its overseas loan book, what hope is there for the domestic market?

There is an argument that real incomes have continued to rise in the UK for the past three years at more than four per cent a year and that this, combined with low interest rates, makes marketing loan capital to the British domestic property market a more than sound idea.

All that could go horribly wrong, of course, if unemployment levels (to which Lloyds TSB is contributing in no small way) were to rise dramatically and a credit squeeze triggered a collapse in the overheated property market.

We shall see about that, but more immediately I believe there is a particular cause for concern in the UK domestic property mortgage market. This is the recent boom in the buy-to-let sector, where house purchasers draw mortgages for the express purpose of letting the property.

In this way, the repayments are subsidised by rent income and the purchaser hopes simply to leverage the capital value of the property. This market has taken off since the 1988 Housing Act introduced short-hold tenancies, allowing landlords to evict tenants more easily.

In 1996, a clutch of lenders did a deal with the Association of Residential Letting Agents, reducing commercial mortgage rates to bring them closer to residential rates. The parents of my children’s friends now spend their weekends scouring inner London for likely-looking properties which they can purchase as landlords.

The number of buy-to-let mortgages rose by 75 per cent in 1999 and their total value increased by 126 per cent. The private rental market has grown by 23 per cent since 1988, fuelled partly by the ridiculous concept of a capital city in which first-time buyers and public-sector workers can’t afford to own property.

A question arises as to how this new generation of Rachmans and Rigsbys will react when the property market corrects, as it must. Will they follow the rubric of experienced property developers, appreciating that theirs is a long-term market and will weather a downturn?

I rather doubt it. Buy-to-let has all the hallmarks of an investment fad – more like ostrich farms and Dutch tulip bulbs than a new economic revenue stream. When the property market turns down, the buy-to-let enthusiasts will sell out, further weakening a falling market.

It’s difficult to know how much the likes of Lloyds TSB are committed to the buy-to-let market. But we do know how over-enthusiastic such lenders become during the good times – remember the Black Horse estate agency chain?

Buy-to-let mortgages are icons of the artificial prosperity and phony bullishness of property markets. We will look back on them with amusement or shame, depending on whether we were involved.

George Pitcher is a partner at communications management consultancy Luther Pendragon